3. optimal capital structure Aa Aa Rosewood Fabrics and Taggart Security Systems

Question

3. optimal capital structure Aa Aa Rosewood Fabrics and Taggart Security Systems are two firms trying to identify their optimal capital structure. Rosewood's CFO has gathered the following financial information to help with the analysis Debt Ratio Equity Ratio EPS DPS Stock Price 1.25 0.55 36.25 20% 80% 30% 1.40 0.60 37.75 40% 60% 1.60 0.65 39.50 50% 1.85 0,75 38.75 60% 1.75 0,70 38.25 Which capital structure described above is Rosewood's optimal capital structure? O Debt ratio 30%; equity ratio 70% O Debt ratio 20%; equity ratio 80% O Debt ratio 60%; equity ratio 40% O Debt ratio 50%; equity ratio 50% O Debt ratio 40%; equity ratio 60% Taggart's CFO also has collected financial information regarding the firm's capital structure, shown in the following tabl Debt Ratio Equity Ratio rd rs WACC 10% 7.00% 100, 50% 9.87% 20% 80% 7.20% 10.80% 9.50% 30% 7.70% 1.40% 9.37% 40% 8,90% 12,20% 9.46% 50% 10.30% 13.50% 9.84% Which capital structure described above is Taggart's optimal capital structure? O Debt ratio 30%; equity ratio 70% O Debt ratio 50%; equity ratio 50% O Debt ratio 40%; equity ratio 60% O Debt ratio 10%; equity ratio 90% O Debt ratio 20%; equity ratio 80% Would an increase in the corporate tax rate tend to encourage firms to increase or decrease their debt ratio? O Increase O Decrease Suppose reforms to the bankruptcy code are expected to make bankruptcy less costly to firms. Is this likely to encourage firms to use more or less debt? O Less O More

Explanation / Answer

Answer-1:

Optimal capital structure is that capital structure at which the shareholder’s wealth is maximized. In other words Optimal capital structure is that capital structure at which Stock price is higest.

Hence the Optimal capital structure for Rosewood is :

Debt 40% and Equity 60% (Stock Price is maximum $39.50)

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